Tactical Asset Allocation – June 2021

Tactical Adaptive Strategies Update

Performance

All three TAAStrategies were up for the month of June.

Adaptive Global finished with a gain of 2.90% for the month and 14.77% Year To Date. The gain was led by our positions in big caps, especially growth.

Adaptive Income finished with a gain of 1.05% for the month and 7.49% YTD. Adaptive Income was invested entirely in high yield muni.

Adaptive Innovation finished with a gain of 2.26% for the month and gain of 0.26% YTD. Our  innovation funds were up sharply; however the funds were heavily hedged due to recent high volatility.

Perspective

July will be the 10th consecutive month during which we will have held the same set of four ETFs in the Adaptive Global strategy.

However the percentage allocations within the four ETFs have shifted every month. Wouldn’t it be easier to just equal weight the allocations?

Having developed the strategies, I already know why we don’t equal weight allocations but subscribers may have the same question. Here is the answer, plus a new choice.

The Adaptive Global strategy employs Limited Portfolio Volatility Weighting which weights allocations according to their volatilities and allows us to specify a limit for the expected portfolio volatility. (A recently updated blog post, The TAAStrategies, A Short History,  provides more background as does the Adaptive Global whitepaper.)

But what if we equal weight the allocations? What are the trade-offs over the 21 years of history we present in the performance table?

  • Compound Annual Growth Rate improves from 15.1% to 15.6% (a 3% improvement)
  • Maximum Monthly Drawdown increases from 7.7% to 9.7% (a 26% increase)
  • Ulcer Index increases from 2.2% to 2.6%
  • Standard Deviation of Returns increases from 9.4% to 10.5%
  • Up/Down Ratio of Monthly Gains / Losses decreases from 356% to 329%

Bottom line? We sacrifice a bit of return for increased safety. These trade-offs are typical of my strategy development work. When presented with a trade-off between increasing returns and lowering risk, I always come down on the side of lowering risk. When given the opportunity to improve returns on a risk adjusted basis, I grab it.

It occurs to me that some subscribers may prefer to accept the increased risk for the convenience of equal weighting with the Adaptive Global strategy. While not a choice I will follow, the risks of doing so appear to be moderate.

Market

From the June 25th Market Monitor

“All major indexes were up strongly for the week led by most of last week’s losers including small and mid caps and the Broker Dealer and Banking Indexes. The rise in the Housing Index, which appears to be in trouble, lagged the group. The S&P 500 made a new high and continues toward my targets at 4350 and 4531. Most of the indexes are Bullish with bearish divergences on both short and intermediate term basis which suggests the market is getting tired.

Value has dominated growth for the past few months but there are signs of a pending reversal. Concurrently, breadth appears to be narrowing in favor of mega caps.

It is the Ru2000 which I am watching closely as it launches a 5th attempt to break out of a 4 month consolidation. A failure would not be healthy for the general equity market although the mega caps could move higher.

The major volatility indexes for the S&P 500, NASDAQ 100, Russell 2000 are confirming the rally.

Cumulative Advancing Declining Volume continues to deteriorate, but in slow motion. 4 of the 5 S&P indexes and 10 of the 12 sector indexes are bearish. On a brighter note, the broad S&P 1500 led off the week with 13:1 advancing volume; however, total volume was light. We need another day of strong advancing volume on high total volume to move the broad market upward. 

The real bright spot is in the Credit Markets where US, EU, and EM spreads and yields are generally either flat or declining. My Credit Market Index generally provides early clues regarding a shift in investor risk appetite. None are visible at this time.

I continue to keep a close eye on the 10 year Treasury which appears ready to make a move out of its consolidation. While there has been a lot of noise during the past six weeks, the end result has been a tight weekly closing range of 1.45% to 1.63% with this week’s close in the middle at 1.54%.  I’m not ready to throw in the towel on my 2% target because we have not gotten a decisive break below 1.5%. That said, the up/down risk appears to have moved closer to even. The market seems to believe that the price inflation risk is “transitory”. I tend to share that view on a short term basis; however that is not likely to avoid pressure for rates to move higher on strong issuance.

The real yield on the 10 year Treasury is 1.54% less inflation of 5.0%.

There are a number of critical forces which are competing for influence in the Treasury market. These include inflation, the trend of the US Dollar, the growing deficit, and a growing Fed balance sheet. A major shift in any one of these could quickly alter the trajectory of the equity market.

The market internals have remained constructive in spite of extreme equity market valuation including Market Cap / GDP now at a record 204%. We are now seeing momentum, breadth, and volume weaken while volatility and the credit markets remain favorable. The game has moved a bit closer to the edge and watchfulness is warranted.”

Thank you for reading.

Earl Adamy

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Compares performance of the Tactical Adaptive Strategies to the S&P 500 and Vanguard Balanced Index Fund

Supporting tables for Tactical Adaptive Global. S&P 500 (SPY) and Vanguard Balanced Index Fund (VBINX) can be found below

Our backtest results tables are constructed for two full market cycles beginning in January 2000.

The most recent market cycle covers October 2007 to date. The fund baskets for our tactical strategies are constructed from indexed Exchange Traded Funds (ETFs) with just two exceptions, an Open End Fund and a Closed End Fund, both with long history.

The earlier market cycle covers January 2000 through September 2007. A number of the ETFs we use were not created until later in the decade. For those cases, we infill using predecessor Open End Funds (OEFs) for which the indexing and/or subclass is substantially similar to the ETF. Aside from providing insight into possible strategy performance during a second, earlier, cycle, they also offer the advantage of completely out of sample data. The fact that the metrics of both cycles are very comparable appears to validate the process.

We have been asked if it is possible to extend backtests to earlier decades. While this appears to be a common practice with some services; it is not possible to produce credible results for many strategies due to the lack of funds with substantially similar indexing and/or subclass. Doing so would force me to stretch the term "substantial" far beyond my comfort level.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

Benchmark S&P 500 (SPY)

Benchmark Vanguard Balanced Index Fund (VBINX)

Compares performance of the Tactical Adaptive Strategies to the S&P 500 and Vanguard Balanced Index Fund

Supporting tables for Tactical Adaptive Income, S&P 500 (SPY) and Vanguard Balanced Index Fund (VBINX) can be found below

Our backtest results tables are constructed for two full market cycles beginning in January 2000.

The most recent market cycle covers October 2007 to date. The fund baskets for our tactical strategies are constructed from indexed Exchange Traded Funds (ETFs) with just two exceptions, an Open End Fund and a Closed End Fund, both with long history.

The earlier market cycle covers January 2000 through September 2007. A number of the ETFs we use were not created until later in the decade. For those cases, we infill using predecessor Open End Funds (OEFs) for which the indexing and/or subclass is substantially similar to the ETF. Aside from providing insight into possible strategy performance during a second, earlier, cycle, they also offer the advantage of completely out of sample data. The fact that the metrics of both cycles are very comparable appears to validate the process.

We have been asked if it is possible to extend backtests to earlier decades. While this appears to be a common practice with some services; it is not possible to produce credible results for many strategies due to the lack of funds with substantially similar indexing and/or subclass. Doing so would force me to stretch the term "substantial" far beyond my comfort level.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

Benchmark S&P 500 (SPY)

Benchmark Vanguard Balanced Index Fund (VBINX)

Compares performance of the Tactical Adaptive Strategies to the S&P 500 and Vanguard Balanced Index Fund

Supporting tables for Tactical Adaptive Innovation, S&P 500 (SPY) and Vanguard Balanced Index Fund (VBINX) can be found below

The Innovation ETFs used in the Innovation Strategy were not established until 2014-2015 so our history is limited. There are no predecessor funds which are similar enough to use for infill.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

Benchmark S&P 500 (SPY)

Benchmark Vanguard Balanced Index Fund (VBINX)